Payroll deductions are money taken from an employee’s paycheck to pay for taxes, benefits, or other financial obligations (like wage garnishment for child support). If you’re setting up payroll for the first time, you’ll want to pay attention to the different types of payroll deductions.
If you need to calculate payroll deductions and take home for your employees, check out this Paycheck and Payroll Calculator.
Not all payroll deductions are created or managed the same way. Here’s how to look out for them and what happens if you make a mistake.
Payroll deduction types
There are three main types of payroll deductions:
Pre-tax deductions and contributions
Local, state, and federal payroll taxes
Post-tax deductions and contributions
Pre-tax deductions
A pre-tax deduction is money that is taken out of an employee’s total amount of pay (aka gross pay) before any taxes are withheld from their paycheck.
Pre-tax deductions reduce an employee’s taxable income, which means they will likely owe less income tax and/or FICA tax (which includes Social Security and Medicare).
Pre-tax deductions can also lower employer-paid taxes, like FUTA (the Federal Unemployment Tax), FICA, and SUI.
Not all pre-tax deductions are the same. Some deductions are considered pre-tax for all taxes, while others may still require certain taxes (like state taxes) to be withheld. Also, there are caps on some items in the pre-tax category. For example, the IRS caps how much can be contributed annually to a pre-tax 401(k) plan.
Common pre-tax deductions/contributions include:
Retirement funds. Contributions to some employer retirement plans, like a traditional 401(k), can be a pre-tax deduction.
Health insurance. Health benefits, like health insurance, flexible spending accounts (FSAs), or health savings accounts (HSAs), may allow pre-tax deductions. If your employee pays for health insurance through a health plan offered by your company, the insurance premium contributions could be pre-tax.
Commuter benefits. Some commuter benefits are eligible for pre-tax deductions within certain contribution limits.
Employee withholding taxes
Federal, state, and some local taxes are withheld from an employee’s pay on each paycheck. Income tax withholdings can include:
Federal income tax
State income tax (in states where it’s required)
Any applicable local taxes at the city, county, or municipality level
Employee’s share of FICA (Medicare and Social Security taxes)
State disability insurance (SDI), if applicable
Post-tax deductions
A post-tax deduction (also known as an after-tax deduction) is money that is taken out of your employee’s paycheck after all applicable taxes have been withheld.
Common post-tax deductions include:
Retirement funds. Some employer-sponsored retirement savings plans are post-tax, like a Roth 401(k).
Wage garnishments. If your employee is subject to court-ordered garnishments, then those funds will be removed after their taxes have been withheld.
Union dues, charitable donations, and contributions to 529 college savings plans.
Voluntary payroll deductions vs. involuntary deductions
Voluntary deductions are payroll deductions that employees choose to have taken out of their paycheck, like:
Retirement contributions
Health insurance
College savings plans
For the most part, life insurance is considered a personal expense and isn’t tax-deductible. But some employers make group term life insurance available to workers up to $50,000 in coverage for no extra charge. If employees want to add life insurance for a dependent, those funds are deducted from post-tax pay.
Involuntary deductions are required payroll deductions by law that must be taken out of an employee’s pay, including:
Income taxes (federal, state, and local)
Tax levies
Wage garnishment
Wage garnishment is when a portion of an employee’s salary is taken out to pay an outstanding debt. This includes child support, alimony, and loans that are very past due. The type of debt will determine how much is garnished. For instance, outstanding child support payments could garnish anywhere from 50% to 65% of your wages. Student loans will garnish up to 15% of your wages. All wages—salary, commissions, and bonuses—are included in garnishment calculations for an employee’s take-home pay (aka net pay).
How states impact deductions
While there are 42 states that require state income taxes, not all of them are managed the same way. For instance, New Hampshire taxes dividend and interest income, while the rest tax wage and salary income. Some states have single-rate tax structures, while Hawaii has 12 tax brackets.
Where you live and how much you earn matter to how much you pay in state taxes. For an example of where payroll deductions appear on paychecks (including state taxes), watch the video below:
Here's How to Read a Pay Stub [With Sample Paycheck]
In the sample pay stub below, you can see which taxes are specific to the state. In this case, the state taxes are for California.
Watch out for mistakes
Filing payroll and staying up-to-date on taxes is already enough work, so it’s no surprise that mistakes are common. If you don’t pay close attention, it could cost you. With almost half of small business owners handling payroll solutions themselves, it’s a good idea to know what to do if you run into a snag. Common snags include:
Making a payroll mistake. This could be underpaying an employee, overpaying, or not including paid time off or vacation hours. You can correct the error by issuing a check in between pay periods or correcting the mistake on the next pay run.
Missing payroll deadlines. You could face penalties, fees, and a host of other issues with your employees if you don’t pay on time. To avoid these, make sure you carve out time in your schedule to run payroll on your designated days. Set a calendar reminder, email reminder, or whatever else you need to stay on course.
Misclassifying employees. Hourly, salary, staff, contractors, part-time, full-time—not all employees are compensated the same way. Misclassifying an employee could deny them certain benefits and, in some cases, result in underpaying them.
Remember, you don’t have to calculate all this information on your own. Calculating a paycheck can get tricky, so it’s always best to consult a CPA or use a payroll provider to make sure everything is deducted correctly.
How and when do employers report deductions?
Each form you complete comes with its own filing deadline, but they’re typically due quarterly or annually. Deductions are reported through a few different forms, including:
Form 940: FUTA. While both workers and employers pay unemployment tax, only employers complete the FUTA form.
Form 941: Employer’s Quarterly Federal Tax. This form outlines how much federal income, Social Security, and Medicare taxes were withheld from employees every quarter. It’s required filing for almost every U.S. employee. Sometimes, you might need to complete Form 944 instead.
Form 944: Employer’s Annual Federal Tax Return. This is for small employers who have $1,000 or less in withholdings every year and pay those annually instead of quarterly.
Workers will complete their withholding information by using Form W-4. These forms can be updated any time workers go through a qualifying event, like having a child or buying a home. When starting a new job, workers must say how much they want their employer to deduct from each paycheck. If you’re onboarding a new employee and they get stuck on how much to withhold, IRS.gov has a calculator to estimate the right deductions.
Looking for cost-effective payroll solutions for your business? Dive into our guide for expert recommendations and find affordable software that meets your needs.
FAQs
Can an employer make deductions from an employee’s paycheck?
Employers deduct federal and state income taxes from employees’ paychecks, and can also make pre-tax deductions for retirement plan contributions and health insurance if employees want those.
How can employees change or stop voluntary payroll deductions?
If employees want to change or stop their voluntary payroll deductions for things like retirement plan contributions and health benefits, they need to talk to HR or initiate the change themselves if they have access to a self-service employee portal. If, on the other hand, employees want to change the amount of tax withholdings they have, they need to fill out a new form W-4.
How do payroll deductions affect an employee’s take-home pay over time?
Payroll deductions reduce your employees’ gross pay, but deductions also lower employees’ overall tax liability.
What documentation should employers keep for payroll deductions?
Employers should hold onto at least three years of payroll records, including pay stubs and payroll ledgers, employee withholding forms (like Form W-4 and Form W-2), employee timesheets, and tax documents like Forms 940, 941, and 944.
How are payroll deductions handled for terminated employees?
Payroll deductions work as usual for terminated employees. You need to make sure you’re still withholding federal, state, and local taxes from your employee’s final paycheck, and following state laws for when to issue the final paycheck.
